Why startup employees are looking for a higher chunk of stock options

September 2013: Twitter acquired MoPub, an ad tech company, for $350 million. Perhaps as remarkable as the transaction itself was founder Jim Payne’s zeal in turning 36 of MoPub’s 100 employees into millionaires. Payne, a startup employee himself at one time, could do that by offering performance-based stock option grants regularly since founding the company in 2010.

MoPub even offered employees loans to exercise their options long before the deal was cut.

September 2016: Some 15 employees at Mumbai-based fintech startup Citrus Pay turned crorepatis when online payments service provider PayU bought out its smaller rival in an all-cash deal estimated at $130 million; an office boy, who was one of the first employees at Citrus Pay, took home Rs 50 lakh. Like MoPub’s millionaires, the Citrus Pay crorepatis had found an avenue to encash their employee stock options (ESOPs) to hit the jackpot. It’s a long shot, and observers concede as much.

“ESOPs were a lottery, are a lottery and will always remain a lottery,” says Rishabh Lawania, founder of Xeler8, a market intelligence platform for venture capitalists and companies.

"The only thing that’s gonna change in the nature of this lottery is the probability of one winning it.” As the startups ecosystem in India, points out Lawania, moves towards consolidation, marked by mergers and acquisitions and buyouts — the latest being MakeMyTrip buying out rival firm Ibibo earlier this week — the chances of winning this lottery will brighten massively. He backs his hypothesis with data: while in the first quarter of this year the number of mergers and acquisitions of startups stood at 40, it jumped to 65 in the July to September period (See Top acquisitions in 2016).

In lieu of cashThe trend, contends Lawania, will only gather momentum as funding becomes increasingly difficult to raise. This will increase the chances of winning the lottery, he says, adding that for a startup employee, there are only two ways to encash ESOPs: either when the company gets listed or when it’s bought. While listing is a bleak possibility for any Indian startup, a buyout is a more realistic option. In the past decades, the road to millions was mostly found by tech giants that made public offerings and got listed on the stock exchanges.

Google, for instance, got listed just six years after it was founded, creating close to 1,000 millionaires virtually overnight; and back home Infosys took 12 years to get its shares listed, in 1993, spawning a rash of millionaires not just post-IPO but with a series of annual ESOP offerings in the years that followed. IPOs are rarer these days, and employees-turned-millionaires even rarer.

But it’s a consolidation phase that’s tentatively begun in startups that may result in ESOPs regaining their lustre. Few saw that coming, as Jitendra Gupta who founded Citrus Pay in December 2010, will testify.

“There were many who chose an all-cash package instead of ESOPs,” says Gupta. And recently when they asked if they could revert to ESOPs, Gupta had little choice but to reply in the negative: they had missed the bus! Gupta maintains that if one wants non-linear growth in life, then one has to take risks as there is nothing called guaranteed outcome with ESOPs. Employees who join startups won’t do justice to their risk ability if they don’t opt for ESOPs in lieu of a cash component, he says, adding that he was sad to see over 95% of hires not caring for ESOPs.

“I had a tough time convincing potential hires, explaining the value-creation opportunity through ESOPs,” recalls Gupta. That mood may be changing as a steady stream of startup employees begin trading off a fat salary package for stock; some even taking a pay cut as high as 75% just to ensure that they maximise their chances of a windfall.

Hopping on the rocket rideRaghu Mallena in Bengaluru is one startup guy who took the high-risk, high-reward gamble. The chief technology officer at Plackal, maker of a women’s health tracker called Maya, joined the firm in April this year from Juniper India where he was head of the security business unit for three years. Mallena, who set up NetApp’s first engineering team in India and also had a stint with Cisco, took a salary cut of 75 per cent but in return pocketed ESOPs.

“There is no point playing conservatively if you have already taken the leap of faith to join a startup,” says Mallena. While one can make up for the lost salary by going to a big company in future, one can never make up for the lost ESOP opportunity.

Raghu MallenaCTO, Plackal, maker of a woman’s health tracker, BengaluruJoined Plackal in April this year from Juniper India where he was head of security business unit for three yearsEarlier set up NetApp’s first engineering team in India; also worked with CiscoSALARY CUT: 75%ESOP: Yes

“Imagine how stupid you would feel if you joined Google pre-IPO and negotiated a 50 per cent higher salary in return for half the ESOPs,” grins Mallena who, after spending his career in corporate roles, took some time off to explore a few offbeat ideas: one of them was joining a startup. Would he advise employees to take a huge pay cut and opt for ESOPs?

“The first thing to ensure,” he answers, “is that the salary meets one’s basic financial needs.” Beyond that, if it is a trade-off, one must go for ESOPs. He adds that the move to take a risk is quite similar to managing one’s financial portfolio, where only 20 per cent of investment would be in highrisk, high-reward instruments and the rest in safer options. So if one works for 25 years, then spending five years (20 per cent) in a high-risk, high-reward job is logical. “It makes sense not just financially but also for the five years of enriching experience.”

For Ashwin Venkatraman, the trigger to join a startup by taking a 50 per cent salary cut was not only the financial rewards that ESOPs might bring in but a feeling of ownership that comes with them. “You feel deeply invested in the company’s success and growth,” says Venkatraman, who joined as chief operating officer at Furlenco, a furniture rental startup in Bengaluru in April last year. While he worked at InMobi as product head for four years before joining Furlenco, he has already had stints with Infosys and Google

Jitendra GuptaMD, PayU India, an online payments startup Founder of Citrus Pay, which was bought by PayU in September this yearOffered ESOPs to 51 employees at Citrus Pay;15 turned crorepatis after the buyout

“I wanted to have the opportunity to build Jitendra Gupta something from ground up,” he says. Though taking risks is in the DNA of Venkatraman — 10 years ago he quit a high-paying investment banking job to join a lesser known company at that time in India (Google), and six years ago he left Google to join InMobi — he had never taken such a big leap of faith.

“It’s like leaving the cushy first-class cabin of a train and boarding a highly questionable rocket-ship,” he says. One never knows, he lets on, if it will explode or fly. While conceding that ESOPs are a lottery, Venkatraman believes that one can influence the outcome to a large extent.

But what if the ESOPs don’t materialise? As long as one is not trading one’s basic necessities for ESOPs, it’s okay to take the risk, he reckons. He sounds a note of caution by rewinding to the first dotcom boom in the ’90s. A lot of paper millionaires were made in the US but, when their stock options turned out to be worthless, they were left with huge credit card bills and nothing in their wallet.

Ashwin VenkatramanCOO, Furlenco, a furniture rental startup in BengaluruJoined in April 2015 from InMobi where he was product head for 4 yearsEarlier worked with Infosys and GoogleSALARY CUT: 50%ESOP: Yes

“So startup employees do need to understand the risk,” he says. At the same time, he adds, one doesn’t want to become a Ron Wayne. The lesser known Apple founder sold his 10% holding shares for $800 in 1976; that stake would be worth roughly $63 billion at current prices.

“You don’t worry about the comfort of your seat on a rocket. Just strap up and enjoy the ride,” adds Venkatraman.

Another employee enjoying the rocket ride is Sreejita Deb. The chief business officer at Flyrobe, a fashion rental startup in Mumbai, joined the company in December last year from InMobi, where she was vertical head for a year. The MBA grad from Harvard Business School took a salary cut of 35% despite offers that were 60-75% higher, claims Deb, who had also worked at Twitter in Silicon Valley. The move, she asserts, has paid off. The biggest reward is to see something grow from 0 to 1 and realise that it happened because of you, she says

Sreejita DebChief business officer, Flyrobe, a fashion rental startup in MumbaiJoined Flyrobe in December 2015 from InMobi, where she was vertical head for a year.Earlier worked at Amazon India and Twitter in Silicon ValleyThe MBA grad from Harvard Business School had offers that were 60-75% higher than Flyrobe’sSALARY CUT: 35%ESOP: Yes

“There wasn’t a brand on whose back you were standing, no prior history on which you were building.” Deb believes that risk appetite of a person depends on his or her personal situation. If someone has an ageing parent to take care of or young children to think about or several liabilities, then it may not be realistic to take a massive paycut and opt for ESOPs. Another consideration is the stage of the company: if it’s an early-stage startup, and if one is convinced about the founding team, then one should opt for ESOPs

Tanuj ChoudhryVice-president (growth), HomeLane, a home interiors startup in BengaluruJoined in March 2015 from Amazon where he was senior product managerEarlier worked for six years at McKinseySALARY CUT: 30%ESOP: Yes

Like Deb, Shuchi Shukla too wanted to be part of a growth story. The chief of staff at Belong, a data-driven hiring startup in Bengaluru, Shukla joined in August last year from Bain & Company where she worked as consultant.

“You don’t just want to do your job, take your salary and go home, but actually invest yourself in building the company that you own a part of,” says Shukla, who took a salary cut of up to 40% and had earlier worked with investment management teams at Accel Partners and Flipkart. When you put in so much, ESOPs become the way to aspire for a disproportionate share of returns of the company’s success as well, she says. That gamble doesn’t always pay off, and HR experts aver that the risks are loaded against the startup employees betting big on ESOPs.

“For every Infosys, there would have been 100 or 1,000 tech startups that bit the dust — the same goes for their ESOPs,” says Padmaja Alaganandan, people & organisation head at PricewaterhouseCoopers India. ESOPs are a vehicle with inherent risk and uncertainty, she adds. If 99 of 100 startups fail, then it is logical that 99 out of 100 startup ESOPs will also fail to deliver value, adds Alaganandan.

Shuchi ShuklaChief of staff, Belong, a data-driven hiring startup in BengaluruJoined in August last year from Bain & Company where she worked as consultantEarlier worked with investment management teams at Accel Partners and FlipkartSALARY CUT: 30-40%ESOP: Yes

High-risk gamble

Manish Mehrotra is a startup employee who threw caution to the winds and opted for a higher chunk of stock options when he joined a grocery startup in Gurgaon in December 2014 at a very senior level. While the going was great initially and the startup was among the heavily funded ones, it hit choppy waters early this year and eventually shuttered.

“I committed a blunder,” rues Mehrotra, adding that he didn’t understand the nature of the beast. Mehrotra thought that he would be able to encash his ESOPs after the vesting period of four years. But little did he know that the startup would fold within three. Like Mehrotra, Pooja Sahni too opted for a huge chunk of ESOPs when she joined an online payments company as product manager. Unlike Mehrotra, though, she chose to leave in a year. “I thought that I would get to encash the ESOPs after a few months,” she says.

“I can’t stay at one place for four-five years.” Alaganandan of PwC India believes that it’s unfair to blame the vehicle without fully understanding the risks associated. Part of the problem, she contends, lies with unclear or misleading communication regarding ESOPs and their potential value by the prospective employer who may be keen to pitch them as a pot of gold or a guaranteed gain.

Vinay BagriCEO, NiYO, a fintech startup in BengaluruJoined in March this year from ING where he was business head for three yearsEarlier had stints with Parle and ICICISALARY CUT: 50%ESOP: Yes

Another part of the problem lies with an inadequate understanding of the risks that prospective employees take while accepting these offers, as well as the expectation around an immediate payout. Another aspect that has given a bad name to ESOPs in startups is lack of clarity on issues such as the exercise price and the fair value. “It further leads to lack of transparency and confusion in the minds of employees,” she says.

Unless an investor or the public actually pays for the valuation that a startup is commanding, all gains are notional. Citrus Pay founder Gupta, though, has proved that the gains can be real. Of late, he has got calls from a couple of founders who cursed him because suddenly their employees are now asking for formal ESOP letters. “Seems like change is in the air,” he grins.

“A divorce could reshape the global wealth ranking. If the couple split their fortune equally, it could leave wife MacKenzie with $69 billion, making her world’s richest woman. It could also make Microsoft's Bill Gates the planet’s richest person once again,” reported Bloomberg. Amazon founder Bezos was dating Lauren Sanchez, a 49-year-old ex-news anchor.